Surprise! ‘Cheap’ Chinese Labor Isn’t So Cheap Anymore

by James Brumley | July 23, 2012 9:06 am

Concerns about it made their way into the background last year, but it’s no longer a mere concern — it’s a full-blown (and unexpected) reality many U.S. companies are going to have to start dealing with now, or pay a big fiscal price for ignoring it later.

Great, but what’s the “it”? China, long known and loved by American corporations for cheap labor, may be on the verge of pricing itself out of the labor market.

If you don’t believe it, just ask the folks at Yum! Brands (NYSE:YUM[1]). Though the company saw decent performance from its Asian operations, overall profits still dropped[2] thanks to — you’re reading this right — a 38.5% increase in food and labor costs in China. Yum! didn’t further break-down the rising expenses, but it’s unlikely food costs contributed to the bulk of the increasing cost of doing business in the country.

It’s a trend other companies using China’s labor forces are watching closely, and it’s a problem investors of those companies need to take seriously.

In the Beginning …

For those investors surprised by the news — and the trend — FoxConn and Apple (NASDAQ:AAPL[3]) might get the blame for rising payroll costs. FoxConn was the major supplier to Apple that was exposed in February as the quintessential sweatshop[4], with a side of unfair child labor practices just for good measure. The allegations were that Apple knew the FoxConn factories’ working conditions were horrible, and just didn’t care.

Whether Apple really knew or not isn’t relevant, as measures are now under way to improve pay and working conditions at FoxConn’s worksites. Those improvements aren’t happening cost-free, though, and it’s largely expected that those rising costs ultimately will be passed along to Apple customers.

This isn’t a ball that FoxConn got rolling on its own, however. In fact, it wasn’t a ball FoxConn got rolling at all.

Although China’s rate of economic growth is slowing, a little perspective might be in order. In Q2, the country’s GDP growth rate was “only” 7.6%. It’s less than the 9.5% growth rate from a year earlier, but at 7.6% growth, companies still have to scramble to find workers, and employees can afford to be picky about jobs they take and keep.

And that’s exactly what’s happening. In some regions, wages have gone up as much as 30% this year alone. Other studies say labor costs have gone up 20% per year for the past four years. And these workers continue to seek out better benefits and better working conditions. (Much like the United States’ Gen-Y, twentysomethings in China want to get more and give less, and like the United States’ Gen-Y, they’re getting it because employers have to hire somebody to fill positions.)

It’s not a trend that’s apt to end soon, either, as China’s population ages, the one-child policy still stands, and its currency still is essentially — even if not officially — pegged to the currency of the country’s biggest customer: the United States.

Who’s At Risk?

Yum! Brands and Apple might be the first clear casualties of China’s rising labor costs, but those two certainly won’t be the last.

Take Collective Brands (NYSE:PSS[5]), for instance — though, you might know the shoe company better under its retail store’s name, Payless. One of the ways it remained a pricing leader in the shoe retail world was that it acted as its own low-cost supplier. It was able to do that because it relied on low-cost Chinese labor. It’s not so low-cost anymore, though — so much so that Collective Brands already has moved some of its production from China to elsewhere. If China’s labor costs continue to rise, however, the company might be forced into making some major decisions.

General Electric (NYSE:GE[6]) is another big U.S. name with a huge manufacturing base in China, though it too has started to rethink China. The company already has moved several appliance manufacturing jobs from China back to the so-called “Appliance Park” in Louisville, Ky[7]. Yet, the company still has a lot of jobs being done in China that might no longer be worth the price it must pay.

All told, some experts feel that by 2015, the U.S. could add as many as 800,000 new manufacturing jobs that otherwise would have gone to China just a couple of years ago. Even more amazing: It would be the cheaper option for many of those companies.

Those companies that refuse to make the move might find themselves a little less investment-worthy as a result. Unfortunately, for companies like Yum! that need local labor to operate in the Chinese market, they — along with their investors — will just have to deal with weakening margins.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.